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SECURE Act 2.0: What It Means to Your Retirement

secure act taxes Apr 05, 2022

On March 29, the U.S. House of Representatives passed a bill that could have a significant impact on your retirement strategy. The SECURE Act 2.0 must still pass through the Senate before becoming law, but it got through the House with an overwhelming majority of 414-5.

The “2.0” version adds to the original law that passed in late 2019. In general, some items help Americans save more for retirement, and the piece of legislation is seen as favoring younger savers. Let’s dig into what it means for your retirement!

Key Points:

1. There is more time to perform strategic Roth conversions.

Among the most significant changes involves how required minimum distributions (RMDs) are treated. The SECURE Act 2.0 would increase the starting age for RMDs from 72, as it stands today, to 73 this year and 74 in 2030, and then 75 in 2033.

This means there is a longer timeframe within which you can perform strategic Roth conversions (which is a potential tax-saving strategy whereby you move money from pre-tax accounts like a Traditional IRA to a tax-free Roth IRA—you simply pay ordinary income tax on the converted amount).

2. There is more time to spend down your qualified accounts—like a 401(k) and IRA—to reduce your potential RMD amounts.

The average retirement age is 62, so this leaves a typical window of 10 years to take advantage of not only Roth conversions, but also simply spending down pre-tax accounts.

Since a retiree’s income is often lower in the period after leaving a job and before starting to collect Social Security, it can be beneficial to use pre-tax, qualified retirement accounts during that window so that your RMDs will not be high once you reach age 73 (or 74 come 2030 and 75 in 2033).

Some good news if you happen to miss taking an RMD: the penalty, currently an extremely punitive 50%, would drop to just 25% and could even be as low as 10% under the bill’s terms. This really changes the math on Roth conversions, and even IF you should care about RMDs at all!

3. There is a longer period in which your Social Security might not be taxed.

On the RMD theme, if you have more time before being required to pull money from your pre-tax accounts, then that means your Social Security benefit will have more time to be untaxed.

Consider that if your only income is a monthly Social Security check from, say, age 65 to age 73, that is an extended period over which you can have a very low tax bill. We can also smartly manage your annual tax liability so that you reduce your overall tax burden over the long haul.

The downside is that some experts claim that raising the RMD age actually increases many retirees’ would-be tax owed since accounts will be allowed more time to grow while there will be fewer years over which the account must be withdrawn from. It is a tricky situation that requires proper planning.

4. There is a lower probability that a Roth conversion will be beneficial.

If you have more time to manage your annual tax bill, then Roth conversions might be less valuable.

This depends on your unique situation, so it’s hard to say that Roth conversions will be less popular overall. Roth conversions almost certainly will be suboptimal once retirees face, under the proposed law, larger RMDs in their early to mid-70s (relative to today) while they are also receiving Social Security.

5. Higher catch-up contribution limits for those behind on their retirement savings.

Beginning next year, the bill would allow for individuals aged 62, 63, and 64 to make beefed-up catch-up 401(k) and 403(b) plan contributions from the current $6,500 cap to a new higher $10,000 annual limit. That limit would then be indexed to inflation so it would modestly increase as time goes by.

This feature could be particularly beneficial for folks who have a high income immediately before planning to retire. If you have a more modest adjusted gross income, then you can always sock away money in a Roth IRA and a Roth 401(k) so that more of your retirement money can grow and be withdrawn tax-free. Moreover, IRA catch-up contributions would (finally) be indexed to inflation.

Since 2006, catch-up IRA contributions have been a flat $1,000 above the standard IRA maximum contribution amount.

6. Lost Wealth Transfer Capabilities

With the new IRS guidelines on beneficiary IRAs, Traditional IRAs have lost most of their wealth transfer capabilities. That puts life insurance back in the spotlight as the primary means for people to help their children climb the socio-economic ladder.

Passing down a Traditional IRA has always been problematic, but it’s even uglier under the new proposed law. Under the SECURE Act, most non-spouse beneficiaries who inherit an IRA will be subject to a 10-year withdrawal policy. That means, for example, if a child of the decedent receives a $500,000 IRA, he or she must take that account to zero over just 10 years—that likely leads to massive tax bills during the adult child’s withdrawal window (which might coincide with his or her peak-earning years).

It used to be that the beneficiary could stretch distributions out throughout their remaining life expectancy. As a result of the change, other options should be considered. Life insurance can be a much better wealth transfer tool so that you avoid paying enormous taxes each year. “Pre-death” planning has become especially important.

Two other items:

A - Qualified Charitable Deductions (QCD): Right now, retirees can transfer up to $100,000 per year tax-free from a Traditional IRA to a charity. That transfer can count toward the RMD, and a retiree is not taxed on the withdrawal while the AGI is unaffected. QCDs are great in that you can capture a tax deduction and count it as your RMD at the same time.

The proposed legislation would index the current $100,000 QCD limit to inflation (so that it goes up over time) and allow a one-time QCD transfer of up to $50,000 through a charitable gift annuity or charitable remainder trust.

B - Employer Roth contributions: Today, employers can only contribute to workers’ retirement plans with pre-tax money. The bill would give employees the option to take those matches in Roth accounts. That could be a big win for some workers.

Questions Remaining:

Will it pass? This is always the key question when it comes to retirement and tax-related legislation. It’s difficult to know right now, but the next step is that it must go to the Senate for approval this month.

The SECURE Act 2.0 would then go to the President’s desk to be signed into law. It is widely expected that it will pass sometime this year given strong bipartisan support.

What will the tax brackets be in 2026 when the Tax Cuts and Jobs Act (TCJA) expires? Retirees might face higher taxes starting in 2026 as the TCJA’s lower tax brackets expire. The prior rates would go into effect along with income brackets that would be equivalent to 2017’s but adjusted for inflation. Could that default plan change? Perhaps, but we do not know yet.

Will the IRS update the uniform life expectancy table or RMD calculations? It remains to be seen if the IRS life expectancy tables will be updated like they were for 2022. These figures are used to determine a retiree’s and an IRA beneficiary’s RMD amount.

Tax management has become critical for retirees’ financial success. Changing laws makes it even more challenging for people to effectively manage their retirement accounts. It takes expertise to navigate through the maze that is retirement and tax law nuances. At Yields4U, we work with individuals, couples, and families to ensure they safeguard more of what is theirs. Keeping taxes as low as possible over the long term is a key piece of good planning.

If you would like a FREE Tax Analysis and Review to see how the new SECURE act will impact you.

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